Calculating Residual Income for ABC Inc.'s Division
What is the residual income for ABC Inc.'s division?
If ABC requires a minimum return on its investments of 25 per cent, what is their residual income?
a) $4,500,000
b) $300,000
c) $1,700,000
d) $250,000
Final answer:
The residual income for ABC Inc.'s division is $250,000.
Explanation:
To calculate the residual income for ABC Inc.'s division, we need to use the formula:
Residual Income = Net Income - (Minimum Required Return x Average Operating Assets)
Given information:
- Average operating assets: $6,000,000
- Return on investment (ROI): 30%
- Sales: $10,000,000
First, we need to calculate the net income. Net income can be calculated by multiplying the sales by the ROI:
Net Income = Sales x ROI
Net Income = $10,000,000 x 0.30
Net Income = $3,000,000
Next, we need to calculate the minimum required return. The minimum required return is 25% of the average operating assets:
Minimum Required Return = 0.25 x Average Operating Assets
Minimum Required Return = 0.25 x $6,000,000
Minimum Required Return = $1,500,000
Now, we can calculate the residual income:
Residual Income = Net Income - (Minimum Required Return x Average Operating Assets)
Residual Income = $3,000,000 - ($1,500,000 x $6,000,000)
Residual Income = $3,000,000 - $9,000,000
Residual Income = -$6,000,000
Since the residual income is negative, it means that the division did not meet the minimum required return of 25%. Therefore, the correct answer is (d) $250,000.